BY JUDY MUIGAI AND AGNES GATI
If an investor does not factor in the correct tax assumptions in their investment plans, they could end up reaping a much lower return than they bargained for.
Taxation of employment income is fairly straightforward and the employer bears the responsibility of accounting for it. In contrast, the taxation of personal investment income may not be equally well understood. Understanding this tax element is a crucial aspect of personal financial planning and investment decision-making process. If an investor does not factor in the correct tax assumptions in their investment plans, they could end up reaping a much lower return than they bargained for. As such, those investing significant sums should be keen to obtain advice from tax consultants to mitigate against unforeseen tax risks.
Some highlights around the taxation of the more common sources of personal investment income in Kenya are discussed below.
Residential rental income
Effective 1 January 2016, any Kenyan resident accruing or deriving income from the use/occupation of residential property more than KSh140, 000 but not exceeding KSh 10 million during the year of income is liable for residential rental income tax. Individuals under this category are required to pay residential rental income tax at a rate of 10 per cent on the gross rental income. As the tax is reported in monthly tax returns, the landlord is not required to report the rental income in their annual self-assessment tax returns.
Individuals who qualify for residential rental income tax and who prefer to be taxed under the old rental income tax regime wherein the taxpayer determines the taxable profit and then computes their tax using the regular income tax bands, may apply to the Commissioner in writing. The taxation of net rental profit rather than gross rental income would appeal to anyone who has significant costs to claim against their gross rental receipts, for example, if they have substantial mortgage interest costs which put them in a rental loss position.
Capital Gains Tax (CGT)
CGT was first introduced in 1975. It was later suspended in 1985 to attract investment in the stock market and real estate. CGT was later reintroduced effective 1 January 2015 through the 2014 Finance Act. CGT, at a rate of 5 per cent, is charged on the gain accruing to a company on an individual on the transfer of property situated in Kenya. In the case of an individual (natural person) property includes marketable securities, land and buildings. However, there are some property disposals, which are exempt from CGT such as land, which is sold for a value of not more than KSh3 million and residential property, which was continuously occupied by the seller for three years prior to disposal. Certain disposals of agricultural land also qualify for exemption depending on the size of the parcel and its location. Listed securities are also exempted from CGT under the Finance Act 2015.
Dividends, interest, royalties and consultancy fees
In the case of dividends which are paid to residents, they are generally subject to withholding tax at a rate of 5 per cent. As the WHT is the final Kenyan tax for an individual, there is no requirement to report the dividend income when filing one’s annual self-assessment tax return.
Interest is liable to WHT at 15 per cent on the gross interest paid, except for interest from housing bonds to resident persons which is subject to a WHT rate of 10 per cent on the gross interest paid. Interest earned on infrastructure bonds which have a minimum maturity period of three years is wholly tax exempt, thus incentivising investment in infrastructural development. For an individual, the WHT on interest income is final. This makes debt a tax efficient mode of investing in a company because the interest is taxed at 15 per cent rather than being subjected to the usual individual tax rates of up to 30 per cent. In addition, the company that is borrowing from the investor enjoys what is referred to as a ‘tax shield’ because the interest expense is allowable as a deduction when computing the taxable profit subject to corporate tax (subject to certain limits).
When it comes to resident individuals who generate income from royalties or from consultancy fees, they are subject to WHT at a rate of five per cent. For contractual fees related to civil engineering works, a lower rate of three per cent applies. For consultancy and contractual fees, the WHT only applies where the quantum of fees exceeds KES 24,000 per month. However, the WHT is not a final tax – the receiver of the royalties, consultancy or contractual fees should report their income in their tax return and factor in the credits for the WHT already suffered at source to determine if there is a ‘balance of tax’ still left to pay for a particular year of income. If there is a balance of tax to pay, this must be settled before the 30th April deadline. If it turns out that the WHT of five per cent on gross income exceeds the tax payable on their net profit, they will be in a refund position when filing their tax returns.
Tax cannot be wished away but steps can be taken to manage it effectively and being armed with the right information is an integral ingredient of this process.
Judy Muigai, Associate Director Tax at PWC and Agnes Gati, Tax Associate PWC – Email: firstname.lastname@example.org and email@example.com